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Should Samsung Pursue a Premium-Only Smartphone Strategy?

China and the other developing markets in Asia will only become harder to profit in.

Should Samsung double down on its Galaxy S6 and S6 Edge? Source: Flickr user Kārlis Dambrāns.

You can understand why Samsung(NASDAQOTH:SSNLF) smartphone fans are cautiously optimistic, as reports of the Galaxy S6 and Galaxy S6 Edge selling well in preorders continue to trickle in. After a groundbreaking reception for the Galaxy S4 in 2013, the company found itself unable to provide a strong follow-up offering with the Galaxy S5. The company limped into the second half of the year with year-over-year operating income drops of 60% and 27% in the third and fourth fiscal quarters, respectively.

Samsung's a multifaceted conglomerate, but the company squarely blamed its beleaguered mobile division for the poor performance -- the company decided to limit the number of models in order to focus and specialize. For years, Samsung pursued a bifurcated smartphone strategy by competing against a host of low-end vendors in developing markets, with its high-end Galaxy line competing with Apple(NASDAQ:AAPL) in developed markets.

However, more recently, Samsung's strategy has struggled. In the all-important U.S. market, the company lost its market-share lead to Apple in the three months ended Dec. 2014, according to research firm Kantar Worldpanel. In the developing markets, Samsung finds itself competing against razor-thin margins, and increasing challenges from Xiaomi in the important Asian markets. The question is, should Samsung abandon these low-end markets?

Google's master agreement limits Samsung's Chinese effortsSamsung's agreement with Google is a two-edged sword. Apple chose a closed ecosystem; Samsung, on the other hand, partnered with Google's Android for its operating system and focused on hardware. Initially, this was a lower-risk strategy; but now, it's limiting the upside for Samsung -- even more so in the increasingly important Chinese market.

Without going into too much detail, Samsung is able to heavily modify (fork) Android -- much like Amazon does with its Fire OS-- but that's potentially more problematic than it's worth. Unfortunately, Samsung is stuck with a "darned-if-you-do, darned-if-you-don't" situation.

As a part of Google's master agreement, if Samsung chooses to modify its OS on any phone, it will have to do so on every phone. In the United States, Google's application programming interfaces (APIs) are the keys for communication with third-party apps. It would be difficult to ask developers to build a workaround for Samsung without a significant forked user-base installed, making this the OS version of the "chicken versus egg" problem.

Meanwhile, in China, the position is entirely different. The forked versions of Android -- referred to as Android Open Source Project, or AOSP -- are widely accepted as the norm. This allows vendors like Xiaomi to profit from -- and, more importantly, shape the future market away from -- Google's dominance.

Samsung is, in effect hindered by the master contract. Of course, Samsung's been working with its own Linux-based operating system called Tizen, but its first Tizen phone endured multiple delays, and even changed its target market from Russia to India.

Samsung's choice: Continue as is, or concentrate on the high-end and shape the component market in low-endFor Samsung, the choice is to continue to pursue its current bifurcated strategy, or abandon the developing markets and work with handset vendors to become a powerful supplier to AOSP handset makers. The company should benefit by being able to concentrate on high-margin devices like its Galaxy S6 and S6 Edge in all markets, while it competes to provide high-margin semi-finished goods, like processing chips, to Xiaomi and other vendors.

Even if the company is unable procure significant chip wins, it would no longer have to compete with a host of new units flooding the Asian markets like Xiaomi's new quad-core Redmi 2A that costs under $100, or the new phone from company No. 1 (yes, that's not a typo), which appears to be a direct design ripoff of Samsung's new Galaxy S6.

I question the strategy of fighting for razor-thin markets among increasing competition when the company's hands are tied.

Jamal Carnette owns shares of Apple. The Motley Fool recommends Amazon.com, Apple, Google (A shares), and Google (C shares). The Motley Fool owns shares of Amazon.com, Apple, Google (A shares), and Google (C shares). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Author

Inspired by the idea of "making your money work for you" at a young age, mostly because he was a lazy child, Jamal parlayed that inspiration into a love of the psychology of markets, competitive advantages, and thematic investing. He later shrug off that laziness, with a career that included stints as a mortgage trainer, a financial advisor, a Sr. Investments Communications Specialist, and a stockbroker. Jamal graduated from George Mason University with a bachelors of science in finance, American University with a masters in finance, and is a CFA charterholder.